Suppose Time Warner, Inc., is having a bad year in 2014, as the company

Suppose Time Warner, Inc., is having a bad year in 2014, as the company has incurred a $4.9 billion net loss. The loss has pushed most of the return measures into the negative column, and the current ratio dropped below 1.0. The companyâs debt ratio is still only 0.27. Assume top management of Time Warner is pondering ways to improve the companyâs ratios. In particular, management is considering the following transactions:

Selling off the cable television segment of the business for $30 million (receiving half in cash and half in the form of a long-term note receivable).

Book value of the cable television business is $27 million.

Borrowing $100 million on long-term debt.

Purchasing treasury stock for $500 million cash.

Writing off one-fourth of goodwill carried on the books at $128 million.

Selling advertising at the normal gross profit of 60%.

The advertisements run immediately.

Purchasing trademarks from NBC, paying $20 million cash and signing a one-year note payable for $80 million.

Requirements

1. Top management wants to know the effects of these transactions (increase, decrease, or no effect) on the following ratios of Time Warner: Current ratio Debt ratio Times-interest-earned ratio (measured as [Net income + Interest expense]/Interest expense) Return on equity Book value per share of common stock

Some of these transactions have an immediately positive effect on the companyâs financial condition. Some are definitely negative. Others have an effect that cannot be judged as clearly positive or negative. Evaluate each transactions effect as positive, negative, or unclear.

Here’s the SOLUTION

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